The biggest job facing any investor is managing risk. Take too much and you are flirting with disaster; but take too little and you could cheat yourself out of the returns needed to care for yourself, your family and your heirs.

Fortunately, it's not terribly hard to get this right. You do that by allocating some of your portfolio to equity funds and the rest to bond funds. The key question is how much you should have of each. That's what this article is all about.

At the heart of this presentation is a big table of numbers that shows year-by-year hypothetical returns for 11 combinations of investment assets from 1970 through 2013. You can click here to find the table.

At the bottom, the table shows the worst-case periods an investor would have experienced in each combination. This shows the bad times through which you must persevere if you hope to reap long-term returns like those shown in the table.

Until 2008, the worst-case scenarios shown in this table came from the bear markets of 1973-74 and 2000-02. Now, most of the worst periods involve 2008 and early 2009. The long-term return of every portfolio in the table with more than 20% equity was reduced by those losses. I think the table is now a better guide to what investors may reasonably expect.

(The numbers in this table assume the equity part of the portfolio was thoroughly diversified as described in my previous article, "The Ultimate Retirement Strategy.")

The question now is simple: How much in equities and how much in bonds? A very simple approach is to split all investments equally between stocks and bonds. Such a 50/50 portfolio historically has an excellent record of producing a decent return with much less risk than the S&P 500 index.

The table shows other possibilities. Annual performance figures in each column are for readers who like lots of data. Each of those numbers represents a return that investors got, or would have gotten, in a particular year using a specific allocation strategy (after deducting an assumed annual investment advisory fee of 1% in all cases, except the S&P 500 index).

Let's turn our attention to the figures at the bottom of each column that summarize the 44-year results. For example, if you trace the numbers in the 60/40 column down from the top, you'll see the year-by-year performance from 1970 (a gain of 3.4%) through 2013 (a gain of 11.9%). And you will see that this combination produced a compound rate of return of 10%; its standard deviation, a measure of volatility or risk, was 9.2%. (Keep in mind that lower numbers mean lower volatility.)

The far right-hand column shows that the S&P 500 had a slightly higher return, 10.4%. But that came at a cost of a much higher standard deviation, 15.5%. Compared with the S&P 500, the 60/40 portfolio produced about 96% of the long-term return of the U.S. stock market while subjecting investors to only 59% of the risk.

I would also call your attention to the line near the bottom of the table showing, in percentage terms, the biggest 12-month loss you would have sustained for each allocation. The lesson is this: If you want the returns, you have to be willing and able to sustain the interim losses. Many investors learned this the hard way in 2008 after they had invested too aggressively.

In other words, in real life, you'll never get those appealing returns if you don't stick with the program you select. And you won't stick with the program if you bail out when things get uncomfortable.

I'm struck by the difference between the diversified 100% equity portfolio and the S&P 500 index. The former was clearly superior, with a 15% improvement in return (12% vs. 10.4%). That difference is much greater than it might seem over a long period of years. Over 30 years, $1,000 would grow to $29,960 at 12% vs. only $19,457 at 10.4%. At the same time, the massive diversification reduces risk.

Still, any all-equity portfolio involves substantial risks. Not many investors can be sure they'll keep their cool in the face of losses like those shown at the bottom of the all-equity columns in this table.

A long-term return of 12% may be more than you need to meet your goals. After many years of working with investors, I believe most retirees can meet their needs with a long-term return of 6% to 10%.

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